My son Victor who is hard at word assisting me with tax returns this year, today learned of a little known penalty that hits many average Canadians who file their returns honestly and in a timely fashion every year. If you’d like to know what it is, just visit his blog.
Thanks for reminding everyone about this Vic. Now get back to work!!
Well, it’s tax time again, and so from now until the end of April, The Tax Issue will be devoted to your tax issues. So send in your questions and subscribe to this blog to make sure you don’t miss the answer!
Today’s question is very interesting and it affects many people as more and more are working from home these days.
The Tax Issue
My late husband was a CA and he always said we should not claim some of our home office expenses as it would create some sort of problem when we later sold the house. He died a decade ago and I am the furthest thing from a CA that there is!
Last year, my job changed and I now work at home full-time. My employer issued a T2200 for me to claim office supplies and other expenses. If I claim part of my heat, power and desk chair, will that trigger any problems in two years to come when I sell my house?
The Answer
Don’t worry about selling your home, you’ll be fine!
The fact is, as an employee, you can claim only certain specific expenses as required by law, and those are subject to some very strict conditions. Your employer must require you to work at home. Thus, the requirement for the T2200 form.
In order to claim part of your home expenses, you must meet one of the following two conditions:
You can deduct the part of your costs that relates to your work space, such as the cost of electricity, heating, maintenance, property taxes, and home insurance. However, you cannot deduct mortgage interest or capital cost allowance (depreciation).
To calculate the percentage of work-space-in-the-home expenses you can deduct, use a reasonable basis, such as the area of the work space divided by the total area.
If you need more information on deductions of home expenses or other employment expenses you can claim, you will find it at the CRA website.
Now, back to your late husband and his concerns. The rules on home office expenses are different for self-employed people. They can claim a portion of mortgage interest and depreciation (CCA) in the calculation of their self-employed earnings. However, if they choose to claim CCA, they will likely suffer in the end when the house is sold, since it will not completely be eligible for tax-free treatment as a principal residence. That’s what he was worried about and that’s why most self-employed people are advised not to claim CCA on their homes.
The brain is a wonderful organ. It starts working the moment you get up in the morning and does not stop until you get into the office. –Robert Frost
Despite the limitations placed upon it by recent legislation and unfavourable court rulings, the family trust remains alive and thriving more than ever. More and more taxpayers are beginning to appreciate the tax saving possibilities of income-splitting.
The discretionary family trust generally provides for maximum flexibility with respect to income splitting. The trustee has the power to allocate income or capital of the trust to the beneficiary of his choice.
In a simple structure, a trust is created, with children and/or a spouse as beneficiaries. The trust owns shares of an operating company (“Opco”) which pays annual dividends to the trust. The dividends are then distributed to the beneficiaries and taxed at their graduating marginal rates.
One interesting spin on the family trust is to add a corporation to the list of trust beneficiaries. This option, although it involves more legal and accounting costs, provides even more flexibility and advantages to the common family trust.
In an income splitting situation, it may not be desirable to pay more dividends to the beneficiaries than they require. If Opco has high retained earnings, its directors may find such a limitation restraining.
Adding a holding company (“Holdco”) to the list of beneficiaries wipes out this limitation. Opco could pay a large dividend to the trust. The trustee would allocate a portion of the dividend to the individual beneficiaries, and the excess would be assigned to Holdco.
A dividend paid by one corporation to a connected company is non-taxable. However, since Holdco does not own any shares directly in Opco, care would have to be exercised to ensure that the two companies were technically connected for tax purposes. Generally, this could be accomplished if Opco and Holdco were controlled by persons who do not deal at arm’s length with each other.
Where Opco generates high levels of cash, the ability to pay dividends in this manner provides certain advantages. First, it allows protection from creditors in that cash may easily be moved out through dividends and away from potential claims.
Where individual beneficiaries have not claimed their capital gains exemption, this structure provides an easy means of having the company qualify as a small business corporation by paying excess “non business” cash out as a dividend.
Sometimes, the implementation of a family trust involves an estate freeze. In such a case, corporate attribution rules may apply to assign deemed dividends to the value of preferred shares issued to a parent as part of the freeze. One exception to this rule is to ensure Opco remains a small business corporation throughout the year. The ability to pay unlimited dividends to the trust on an ongoing basis would allow Opco to retain its small business corporation status so the exception. applies.
Finally, if the trust is wound up, it may be possible to distribute the Opco shares to Holdco free of tax, thereby eliminating the need to give up eventual ownership of the shares to children.
Of course, before implementing any such complex structure, care should be taken to ensure that all legal requirements are met, and that the tax advantages are worth the added costs
So you’ve split up with your significant other, and you’re forced to make support payments. The first thing you’ll be asking me is, “are they deductible?” Well, just like your relationship, it’s complicated. That’s what The Tax Issue is here for.
There are two basic requirements before you even consider taking a deduction. First, the payments must be based on a written agreement or a court order. Second, they must be periodic payments. Lump sums or payments based on a mutual, non written understanding are not deductible.
Once you’ve passed these hurdles the rules are different depending on when your agreement or court order was signed. We’ll tackle them one at a time, but before we do, you should be aware of one more thing: any amount that is deductible to the payer is also taxable to recipient.
Written Agreement or Court Order After April 1997
If your document is dated after April, 1997, only payments made in support of your spouse (or common law partner) are deductible. Child support is not.
Your agreement must clearly specify which payments are exclusively for spousal support. If no mention is made of the purpose of the payments, they are deemed to be for child support and are not deductible.
Payments made to a third party qualify as long as they are for the benefit of your spouse and he or she has control over them. For example, if a court order specifies that payments are to be made to a landlord for your spouse’s rent, it must also be made clear that your spouse may at any time have those payments made to her instead if he or she so desires.
If you qualify for a deduction under the above rules, you must register your agreement or court order with the CRA by filing form T1158.
Written Agreement or Court Order After April 1997
If your document is dated prior to May, 1997, then payments for spousal support and child support are deductible.
However, if the agreement was amended after April, 1997 and the amount of child support payments is modified, then you fall into the new rules, and they will no longer be deductible.
You can also choose, if your spouse agrees, to have the new rules apply to make the payments non-deductible (and non-taxable to the recipient) by filing an election on Form T1157.
Those are the basic rules. If you need more information, try the CRA guide P102. That should answer most of your questions.
Organizing tax information for your tax preparer can be a daunting task. Do you use a shoebox? a shopping bag? Despite your best intentions, you may not have the time or the knowledge necessary to provide a complete and organized dossier.
Those of use who prepare your taxes just don’t have the time or energy to instruct their clients on how to properly prepare their income tax papers.
And so, as a public service to those beleaguered tax preparers, and to those of you who want your accountant to love you at tax time, The Tax Issue introduces the Tax Issue Tax Organizer.
The Tax Issue Tax Organizer is a free PDF file that you can download and use as an accountant, to give to your client, or as a client to use yourself to help organize the information you give to your tax preparer and make his or her life a little easier.
How to use the Tax Issue Tax Organizer
Simply download and print the Organizer. Each page represents a section that will let you organize the information for that topic. It starts with a list of the relevant documents you should submit to your tax preparer. Attach each page to a separate envelope or file folder containing the documents for that section.
Each page has a list of Do’s and Don’ts to help ensure that you help your tax preparer by including all the necessary documents and receipts he needs to efficiently prepare your taxes.
Finally, each page contains a few tax tips to help guide you through the process.
Even if you prepare your own tax returns, The Tax Issue Tax Organizer is a great tool to help you prepare.
Have a great tax season and enjoy using the Tax Issue Tax Organizer!
Our House is a very very very fine house
–Crosby, Stills, Nash & Young
The Tax Issue
I am a member (beneficiary) of a family trust that was set up years ago by my Dad. The trust currently owns two houses. I live in one, and my sister, who is also a member of the trust, is married and lives in the other. We were told that we will have taxes to pay we sell our homes. Can this be true? Please help, as no one seems to know the answer.
The Answer
The principal residence rules that apply to personal trusts are surprisingly restrictive and can be a trap for the unwary.
A trust is treated as a person for tax purposes. As such, it does have access to the principal residence exemption on the sale of a home. But here’s the kicker: if a trust designates a home as a principal residence for a given year, then every beneficiary of that trust who lived in a home owned by the trust is deemed to have made the designation. And remember, a person can only designate one property as her principal residence. This applies to a trust as well. This means that if you sell the home you are living in and the trust claims it as a principal residence, then when the trust sells your sister’s home, the trust is precluded from making the designation on the second home. Her home becomes ineligible for the exemption for those years even though it may be the only home she’s lived. This might come as a shock, and it seems unfair, but that is the way the law works.
So, let’s look at an example. Say the trust owned your home since 2000 and it is sold in 2012 at a gain of $500,000. Furthermore, let’s assume the trust owned your sister’s home since 1996, and sells in 2012 at a gain of $400,000. If the trust claims the full principal residence exemption on your home, then it will be precluded from claiming the exemption for the years 2000 – 2012 on your sister’s home. In fact, for the 16 years the trust owned your sister’s home, only 4 will qualify, so only 4/16 of the gain will be exempt. (Actually, the formula generously adds 1 year to numerator, so technically 5/16, or $125,000 of the total gain will be exempt).
Taxpayers thinking about placing personal homes in a family trust should always seek professional tax advise.
The Tax Court of Canada has recently confirmed the tax treatment of Ponzi scheme victims as I feared they would in the very first issue of The Tax Issue.
In a Ponzi scheme, taxpayers unwittingly entrust funds to a promoter, who, rather than investing them, uses them to make payments to other investors. The flow of funds continues this way until enough people finally ask for their money back, at which point, the fraud is exposed.
The taxpayer in the case of Johnson (2011 TCC 540) was a winner because the court ruled that in a Ponzi scheme, there is no investment and thus no source of income. The good news for this taxpayer, a victim of Andrew Lech, was that she was one of the few who cashed in her capital after a few years of receiving what she thought was a great return on her investment. The “income” she dutifully reported over the years was held not to be “income from a source” and thus not subject to income tax.The court stated that “the net receipts were nothing more than the shuffle of money among innocent participants.”
The bad news for those who have lost their investment, however, is that there is no tax relief available for the loss of their capital. In a normal investment, the loss would be considered a capital loss, 50% of which can be used to offset capital gains. For these victims of fraud, since no income source existed, no tax deduction is available on the loss of the investment.
The only consolation is for taxpayers who reported income in past years to amend their returns and request refunds on the tax they paid on the payments received from fraudulent schemes.
Update: The CRA has decided to appeal this decision….To be continued…..
Last week I attended the Canadian Tax Foundation’s annual conference in Montreal. It’s a 3-day event where accountants, lawyers and government officials get together, sing Irish drinking songs, try on each others’ bow ties, and get into all sorts of wild shenanigans.
My favourite time is CRA round table day. That’s when representatives from the government let us tax practitioners know that they’re on our side, they’re here to help and taxpayers have rights. Then they answer a series of pre-determined questions on tax policy confirming that they are not on our side, help is a four-letter word, and whatever rights we have are readily accessible – in a court of law. Anyway, we forgive them because they’re usually the ones who spike the punch every year at the Arthur Anderson reception.
This year, the CRA was asked about the new partnership year-end rules and joint ventures. As we reported in an earlier post, new rules were introduced in the 2011 budget that will essentially eliminate any tax deferral to a corporation whose year-end does not coincide with that of any partnership in which it holds a significant interest.
A joint venture is not a partnership; however, they are often accounted for on a similar basis, with a year-end being established and each participant picking up its share of income annually. This has always been tolerated by the CRA.
With the new rules in place, the CRA stated that joint ventures will now be treated similar to partnerships. Administratively, they will also allow companies with joint venture interests to take advantage of the same transitional relief afforded to partnerships under the new rules. That is, they will be allowed to include 15% of additional stub-period income in 2012, 20% in 2013, 2014 and 2015, and 25% in 2016.
In a technical bulletin released on the same day, the CRA also stated that, going forward, for taxation years ending after March 22, 2011, income from a joint venture will have to be reported for each participant based on that participant’s fiscal period. For participants with different year-ends that don’t coincide with the joint venture, this will likely create some onerous compliance issues.
Those guys at the CRA always keep us on our toes!
Years ago, the Tax Court of Canada introduced its informal procedure, a type of “small claims” court for tax cases. I was intrigued at the time, because it allowed for non-lawyers such as myself to represent taxpayers, under certain conditions. So, I did some research and wrote an article on the topic which was published by CA Magazine. At the time, I hadn’t ever been to Tax Court (I’m confessing this now, years later, having successfully represented 3 clients since). My article was based strictly on research, and some anecdotes from a colleague. Anyhow, I thought I’d reprint an abridged version of that article for old times sake, so here it is:
Entering the courtroom I was less than impressed. It was smaller than I had imagined. And although there was a generous amount of oak trim surrounding me, it somehow felt cold and clinical. Perhaps my expectations were too high. I’ll admit to being a bit zealous. After all, here I was, about to plead a case in the Tax Court of Canada, and I was not even a lawyer.
As a chartered accountant, I was within my rights to represent my client in a tax case. The Informal Procedure Rules were established in 1991 to provide a “small claims court” environment where an individual taxpayer could represent himself without the need to adhere to strict rules of procedure and evidence. A lawyer or an agent, such as an accountant, may also represent an individual in an Informal Procedure case.
Under the rules of the Tax Court, the Informal Procedure may be invoked in an appeal where, for each assessment, the amount of federal tax involved, plus applicable penalties, is equal to or less than $12,000. In the case of a loss determination, the amount in dispute must not be more than $24,000, and where the dispute is in respect of an amount of interest only, the threshold is $12,000.
I explained to my client that the objective of these rules was expediency. Her case would be heard relatively quickly, within a few months of her application. The hearing would be short and a decision would be rendered quickly, usually in the same day, but generally not later that 90 days after the hearing. She would not be subjected to examination by the opposing counsel prior to the hearing. Her risk in the case of an unfavourable judgement would be reduced by the fact that costs could not be claimed against her by the Crown.
After our objection was denied, I had filed a timely Notice of Appeal on behalf of my client with the Registrar of the Tax Court. Since I was a layman, the strict rules of format regarding such a document were relaxed. The court had accepted my Notice, which was prepared in a letter style. However, I had still made certain that the letter contained all the necessary elements. Similar to what you might find in a Notice of Objection, the letter indicated the name of the taxpayer, the details of the assessment and the issues surrounding the appeal.
The judge gave me a curt nod and asked me to begin. I rose from my seat, thanked him respectfully, and gave my opening statement. I tried to avoid showing my anger at the injustices heaped on my poor, suffering client by the cold-hearted tax department. I would be better off, I figured, with a brief and logical summary of my case.
I guided my client logically through the sequence of events, ensuring that she stayed to the point at all times. As we went along, I introduced documents to support the testimony. In the Informal Procedure, the rules governing the introduction of evidence are markedly relaxed.
After cross-examination, I was asked to give my closing argument. I reviewed the evidence and referred to a court case as an authority to support our position. I came to a conclusion based on the facts and the law surrounding the issues, and I once again concluded with a request to have the Minister’s assessment altered. I thanked the court and sat down, hoping no one had seen me sweat.
I was done. I had presented a concise and forceful case. Although I was feeling exhilarated, I wasn’t sure whether I would give up my accounting practice just yet to pursue a law degree. The judge had been lenient with me, knowing I was a layman. The Informal Procedure was designed with non-lawyers in mind…
The Tax Issue
I recently built our “dream” home for 2.50M$. However, not having sufficient funds personally, my professional corporation financed the construction of the house for me, writes off the maintenance, utilities and taxes, and I rent the house from my company at a market value rent, having researched comparable rents in the neighbourhood. Apart from forgoing the principal residence exemption – are there any other detriments to this strategy?
The Answer
Could be. I’m assuming, since you are paying rent, that you’re aware of the shareholder benefit rules. That is, by virtue of the fact that the company has financed your house and pays expenses on your behalf, you are exposed to tax on the value of the benefit you are receiving from the company.
What you may not be aware of is how the CRA might establish the value of the benefit. It could be the market value rent as you have researched, and if so, the rent you’re paying would be enough to offset the taxable amount completely.
In your case, however, it may not be so simple. There is a line of jurisprudence, starting with the case of Youngman v. The Queen, that suggests that the benefit or advantage conferred on you is not merely the right to use or occupy a house; it is the right to use or occupy a house that the company, at your request, had built specially for you in accordance with your specifications. How much would you have had to pay for the same advantage if you had not been a shareholder of the company?
So what is this “alternative” calculation? Generally, the value of the benefit could be calculated by reference to the income the corporation would have earned if its capital had been productively employed and not based on the fair market rental value (which might be considerably lower).
As an example, on a $2.5M capital outlay, the company could have been expected to earn interest in a relatively risk-free investment of, say anywhere from 2% to 5%. This would mean an annual rent of $50,000 to $125,000, plus expenses. If you are paying any less than this in rent, despite what the market rents are in the area, then you could be exposed to a greater taxable benefit than you thought.
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